Healthcare Reform Fails: Implications

The collapse of the healthcare reform bill promoted by President Donald Trump and Republican House Speaker Paul Ryan bolsters our view that Trump's legislative agenda would not proceed smoothly, and that tax cuts and economic reforms would ultimately disappoint lofty expectations. Furthermore, Washington gridlock raises the risks of the White House pursuing policies that do not require congressional approval, including trade protectionism. These outcomes had already been incorporated into our US outlook, as we are already below-consensus on interest rate hikes and growth.

The failure of the Trump administration and Republican House Speaker Paul Ryan to successfully pass the American Health Care Act (AHCA) over the week of March 20-24 raises questions surrounding the future of US health care, the strength of Congressional Republican unity, and the viability of enacting the remainder of Trump's agenda. The AHCA was unable to garner enough support from Republicans, notably the conservative House Freedom Caucus (HFC) and the moderate Tuesday Group, to get to the threshold of 216 votes needed to clear the House (assuming all Democrats would have voted against the bill). A vote on the health care bill was postponed twice, once on March 23 and again on March 24, as Trump's and Ryan's attempts to appease the HFC meant losing moderate Republican votes. The final blow to the bill came when the influential chair of the House Appropriations committee, Rodney Frelinghuysen, pulled his support on March 24, saying that the AHCA would place too many costs on his constituents in New Jersey's 11th district.

House Republicans Are Divided

United States - House Of Representatives Breakdown

Source: BMI

As this was Trump's first attempt at supporting and shepherding major legislation through Congress, his credentials as a dealmaker are significantly tarnished by the AHCA's failure, while the political capital he wasted to amass support for the bill will leave little room for error in pushing through other legislation. How the Trump administration and Paul Ryan handle the fallout from this major setback in the coming weeks will reveal their strategy for passing a budget, tax reform and an infrastructure package. That said, it will be key to keep the following questions in mind over the next few weeks:

How divided is the Republican Party? Very. For seven years the Republican party rallied behind repealing the Affordable Care Act (ACA, also known as 'Obamacare') but when they finally got their chance to do so, party cohesion broke down across the Republican ideological spectrum. Moderate Republicans would not support full ACA repeal without a viable replacement that ensures that coverage is increased at reduced cost. Conservatives, as embodied by the House Freedom Caucus, want a full repeal without strings attached, which is a non-starter for other members of the party. Given that the HFC numbers somewhere between 30-40 members, among 237 Republicans in total, an ACA replacement bill would need to garner Democratic support to reach the vote threshold (216). It is unclear at this moment whether Trump and Ryan will look to go down this path in an attempt to bypass the HFC. However, the de facto second-in-command of the HFC, Jim Jordan, stated on March 24 that the AHCA failure will not deter their members from seeking to repeal the ACA, which could lead to a wider rift between Trump and the HFC if the administration looks to collaborate with Democrats on health care.

Is Paul Ryan's position as House Speaker in jeopardy? Not necessarily. Ryan's leadership credibility has been weakened but he should be able to bounce back and maintain party support. Crucial to watch will be how he handles the fallout in the days after the AHCA failure, if the Trump administration assigns Ryan the majority of the blame, and how he approaches whipping party votes in future legislative negotiations. Regarding the latter, if Ryan decides to bypass HFC members by teaming up with moderate House Democrats, we would expect HFC members to grow more intransigent and look to weaken Ryan's role, as they did in 2015 with Ryan's predecessor as speaker, John Boehner.

Is the ACA here to stay? In its current form, no. Trump and Health and Human Services Secretary Tom Price have tools at their disposal that could undermine the ACA, including reducing the amount of cost-sharing subsidies the federal government sends to states; issuing waivers for state insurance programmes; and reducing enforcement on penalising individuals for not signing up for health insurance. These policies would likely make insurance company participation in the government health care exchange less attractive, increasing the probability that premiums rise, moreso as incentives for healthy individuals to partake in the system fall. If this occurs, Democrats will blame Republicans for wilfully weakening the ACA. Republicans on the other hand will showcase rising health care costs as further vindication that the ACA is a failed piece of legislation. If this plays out in 2017 or early 2018, it could be a crucial factor in the 2018 mid-term elections.

Will the AHCA have 2018 mid-term implications? Yes. Historically, parties that win the White House and Congress fare poorly in the subsequent mid-term elections, and this looks increasingly likely to play out in 2018 for the Republicans, particularly in the House. There are 23 House Republicans in districts that voted for Hillary Clinton in the November 2016 presidential election and Democrats will look to flip these seats in 2018. Trump's open threats of 'going after' Republicans in 2018 if they did not support the AHCA could very well backfire if a conservative Republican primary victor ushers in a moderate Democrat in a swing Congressional district come the general election. There is plenty of time for political events to unfold before the 2018 mid-term election campaign season begins. That said, health care could be the pivotal issue that decides the makeup of the House of Representatives after 2018.

Will the AHCA failure impact tax reform? Yes. Success on health care reform would have produced momentum and confidence that Republicans could act as a governing body, and that Trump and Ryan would be able to push through complicated and controversial legislation. Moreover, the almost USD1trn worth of tax cuts alongside reductions in Medicaid spending would have made revenue neutrality over ten years - a prerequisite in the budget reconciliation procedure - easier to achieve in a tax reform package. The general goal for Trump and the Republicans is to lower income tax rates for individuals and corporations, and make up the foregone revenue by reducing exemptions, deductions, credits and cutting wasteful federal government spending. This is tough to do, because without cutting entitlement expenditures or raising new revenues - measures which Trump appears to oppose - a significant tax cut would widen the deficit. Since the 2016 election, our core view has been that only marginal tax cuts will be enacted, and the failure of the AHCA bolsters our view ( see 'Trump's Legislative Agenda Will Not Be Smooth Sailing', 22 November 2016).

In addition, tax reform as ambitious as Ryan and Trump have proposed will be harder to achieve than health care, in our view. Every tax credit has a constituency, a political action committee (PAC) or a lobbying effort behind it, and some of the most controversial policies are facing significant opposition from interested parties. The border adjustment tax, which is essential in order to raise upwards of USD1trn to offset the cost of tax cuts, is facing considerable opposition from importing companies among others, and its complicated and unpredictable economic consequences will make it a tough sell for many lawmakers. The housing industry and homeowners alike will oppose reforms to mortgage interest deductions. Legislators from high-tax states will come out against removing state tax deductions, arguing that it automatically puts them at a competitive disadvantage with other states.

Tax reform will depend on how early and well the Trump administration reaches out to interest groups, the different Republican factions and the Democrats in order to build as much support as possible. The longer Trump and his advisors wait to reveal their tax plan, the harder it will be to pass by the arbitrary deadline Treasury Secretary Steven Mnuchin has placed on a tax bill - the end of August. Even that deadline may prove ambitious. At the end of the day, the political situation suggests that tax reform will be considerably watered down, and that the magnitude of tax cuts is likely to be smaller than many had hoped immediately following the 2016 elections. This outcome is already factored into our macroeconomic outlook, which is why we are below consensus on rate hikes as well as US growth ( see 'March 2017 - Emerging Markets Recovery Still In Early Stages', 20 March 2017).

What does this mean for the rest of Trump's agenda? There is a rising risk that having tried and failed to achieve one of his key legislative proposals, Trump will become more aggressive in using executive orders and other powers to pursue other priorities. This is particularly true for the key areas of immigration policy, regulation, and international trade. Trump has made inroads in the former two policy areas via executive order already, but has done little on trade, apart from abandoning the Trans-Pacific Partnership deal. Further intransigence by Congress to move on tax cuts, infrastructure, and other priorities could push the White House to begin to pursue more aggressive trade policy. We continue to believe that the potential for protectionist policy out of the US is still, if anything, being under- rather than over-estimated, and we expect the Trump administration to pursue targeted measures against specific countries and their export industries ( see 'Global Shakeup: The New Reality For World Trade', 24 March 2017). The waning prospects for a domestic legislative breakthrough makes the likelihood of Trump seeking a high-profile 'win' on trade all the more urgent politically. In this regard, the planned meeting between Trump and Chinese President Xi Jinping on April 6-7 is likely to take on additional importance.